## Times Interest Earned Ratio | Formula | Calculation with Examples

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topic with us is called time interest on ratio now let’s talk about this in a

detail format you know over here we have an example or a graph of Volvo AB Times and their interest that is the turn ratio is closely 15.83 I’m now going to take you

directly you know what does this mean or how much times what exactly is the

interpretation no first let’s understand a step by step what this ratio is all

about we’ll get back to this and then we’ll analyze that you know what Volvo’s

times interest earned is increasing every year and what does this 15.83 shows us so let’s begin on that so first what is the times interest earned ratio what is

this well C times interest on ratio is basically again a solvency ratio which

measures the ability of the organization to pay its debt obligation also it is

known as we can see that it is interest coverage ratio the lenders commonly use

it to a certain if the borrower can take on the additional own the times interest

ratio is calculated by dividing the earnings of the company before it pays

interest by the interest expense or the ratio is division by simply earning

before interest and tax to interest expense so we wrote from the chart that

saw over here of Volvo if we just try and see look at the analysis we note

that from the about chart of Volvo’s times interest has been steadily

increasing over the time and this is very good situation to be in due to the

company’s increasing capacity to pay interest you can see from 2014 to 2017

and then it goes on and on the graph of is just going up so it’s really good so

analysts should consider but time series of the ratios a single point

ratio may not be very good measure or it may include one time revenue or earnings

but companies with consistent if you see consistent the ratio over a period of

time does indicating you know it’s a better position to service the tip

however you know the smaller company and startups which do not have consistent

earning will have variable duration they will have a

variable ratio over times with us lenders do not prefer to give loans or

to such companies and you know this companies offer higher equity and they

raise money from the private equity venture capital that’s we see let’s

understand this formula now let’s get to the next step that is the formula the

times interest earned formula is equal to EBIT/ interest expense this is the

formula so clearly the ratio gives how many times you know the interest can

cover the interest expense – its pre-tax in pre interest earnings the banks and

the financial lenders often look at various financial ratios – to mind the

solvency of the company and whether it will be able to service its debt before

taking on more debt so the bank’s look at the debt ratio the D to E Debt to

equity ratio and the times interest earned ratio often you know that ratio

and debt to equity ratio if you see for this one is a measure of the capital

structure of the company and it indicates the exposure of the company to

debt financing relative to the assets were equity respectively but however I

know the times interest over here this ratio measures if the company is earning

enough to pay off its interest now high times interest earned ratio is favorable

it is good it’s not bad it is good as it indicates the company is earning

higher than it is and will be able to service its obligation whereas you know

if see for the lower values it indicates the company may not be able to fulfill

the obligations but that may be the case now you need to know that you know many analysts use EBITDA in the numerator instead of the EBIT which I think you

know absolutely fine if you use it consistently over the years that’s

that’s good there’s no problem in that it’s a good measure it’s a good driver

does you know the new ratio becomes you know the time interest on ratio if you

just want to change over here instead of EBIT now this is the extra knowledge

you know I am sharing with you that in or fifth instead of over here if the

companies are like airline companies they have huge rental then you need to

add over here R that is a rentals EBITDA times interest coverage you know

sometimes they take EBITDA are also or a EBITDA if they are paying fees so it

depends upon company to company you which industry in which they are

operating so this is done because you know depreciation amortization expense

are here they count you know not actual cash outflows it doesn’t go out from

your pocket so for the given period so does removing such what we can see

here if you remove such ena over here you know it reflects better earning or

past you the company to pay interest expense arguably the depreciation and

amortisation spends in directly relates to the what

we call as the future business it needs to buy fixed and intangible assets and

thus you know the funds may not be available for the payment of the

interest expense this was the formula now let see the

calculations on the seam let’s take an example here suppose that let’s say you

know you have two companies one is alpha and another one is beta in a similar

industry so the two companies have you know some data over here as below like

you know alpha data and beta well the data of a bet is given 15 million

and 10 million interest expense 5 million 7 million

so in this scenario the company’s alpha is going to EBIT divided by interest

expense and control are so 1.42 so in the above example we can see

no the company alpha has higher times interest on ratio than the company beta

and those relatively company alpha is better financial position than company

beta and the lender will be more willing to give additional debt to alpha then

company to beta so the times through interest ratio of the company beta is

greater than one which indicates that it generates sufficient earning to cover

more interest payments does you know the lenders may look at the other factors

they may look at the other factors like you know debt ratio that to equity

industry standards to decide so companies with the times interest ratio of

if you say less than one are unable to service their debt so they cannot meet

their interest requirements from their owning and they must dig into their

reserves to pay off the obligations now I’ll take you to the Advantage part now

what is the advantage of this of this ratio see it is very easy to calculate

the times interested is indicated or indication of solvency of the company

the ratio can be used as an absolute measure of the financial position you

know the ratio can be used as a relative measure to company two or more companies

and the negative ratio indicates in the company’s are serious financial troubles

now if you see for the disadvantage over here although a good measure of solvency

the ratio has its disadvantage you know we’ll have a look at the floors and that

you know the bad drops of calculating this ratio the first thing is that you

know the earning before interest tax used in the numerator in accounting

figure which may not be representative a EBIT we are talking about enough cash

generated by the company so the ratio could be can be higher it can be lower

it does not indicate the company has actual cash to pay the interest expense

that’s a flaw the amount of the interest expense used in denominator of the ratio

is again an accounting measurements discount they have interest expense to

be paid so towards such issues it is advisable to use the interest rate on

the face of the bonds the ratio only considers the interest expense it does

not account for the principle payment so the principle payment may be huge it

leads to the company to insolvency but further the company may be bankrupt or

may have to refinance what we call as at the higher interest rates and

unfavorable terms so those while analyzing the solvency of the company

are the ratios like debt and equity debt ratio should also be considered

let me give my final thoughts on this C times interest alone ratio measures the

company solvency and its ability to service its debt obligation so this

ratio is indicative of the number of times the earnings to the interest

expense of the company so higher the ratio is better is the financial

position of the company and it is better candidate to raise more more funds and

moded so a ratio of greater than 1 this favorable however lenders should not

rely on the ratio unknown to decide other factors and ratios like debt ratio

that equity industry and economic condition should also be considered

before lending so that’s it for this particular topic if you have learned and

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